Entrepreneurs often seek legal counsel when starting a business. But many forget about the legal ramifications of selling their business, local attorneys say – and that can complicate a sale and reduce the selling price.
In fact, said James H. Hahn, a partner at Partridge Snow & Hahn, in Providence, business owners should think about those things from the start.
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“I would strongly urge anyone starting a business to be thinking, as they’re starting, what the end result of this is going to be,” Hahn said. By devising an exit strategy early on, business owners can be better prepared when it comes time to sell years later.
The first step in planning an exit strategy, Hahn said, is deciding who to sell to, be it a family member via gift or sale, or employees, or a third party – either a strategic buyer, which might be a competitor or someone with industry experience, or a financial buyer, someone who has money to invest. Or it might be to the public, via market shares.
Each option poses different challenges, Hahn said, and those challenges might require legal agreements, contracts, and expert advice depending on the circumstances.
If selling to a third party, business owners should start thinking about how efficiently they keep records, Hahn said. Records upkeep includes how well a business keeps track of its income and expenditures, procedures, operations, contracts and agreements.
Good financial and legal record keeping is “evidence of a well-run business that is less likely to have legal problems,” said Thomas Madden, business law attorney and principal of The Madden Law Firm in Providence. Maintaining accurate records also helps protect owners from exposure to liability, he said.
Smoothing out organizational issues can make a business more attractive to potential buyers and increase its selling price, Hahn said.
“Running your business in a way that someone else would understand what you’re doing” adds value from the buyer’s perspective, Hahn said. It is important to look at a business as a buyer would look at it, he said, and then determine what needs to be fixed.
Running a company as a clearly distinct entity can prevent problems at exit time, Madden said. For example, avoiding the co-mingling of owners’ funds with company funds can prevent instances where owners might be held liable for certain corporate actions. Keeping personal and corporate banking separate helps eliminate those problems.
Incorporating the company also helps limit liability issues upon exiting, he said, as does entering into contracts and agreements as a corporation, rather than as an individual.
“Simple things like that can add up,” Madden said. “It doesn’t matter what [type] the entity is. What matters is whether you are entering into agreements as an entity or an individual.”
Part of a business law attorneys’ job is to ensure the process of due diligence, which means fully understanding all obligations of the business, including debts, leases, warranties, customer agreements, employment contracts, distribution agreements, and compensation agreements.
Making sure every document is accounted for is important, Hahn said. Sometimes an owner offers a share of ownership of the company to employees. In the end the owner might think he owns more than he actually does.
Hahn said business owners thinking about exit strategies should form a team including an accountant, a lawyer, and someone who can provide advice about business valuation. That advice could come from a broker, if it is a small company, or an investment banker, if it is a larger company.
The earlier business owners take certain actions, the easier the exit process will be, he said.
For example, if two individuals start a company and each owns 50 percent, it is important to think about what will happen if one backs out or becomes ill and can no longer help run the business, Hahn said. Planning ahead could mean saving money for a buyout or investing in insurance.
Transferring a business to family members presents its own set of challenges. There are trust documents and tax costs to consider, Hahn said. Also, if a business owner transfers ownership to a child and asks the current manager to train the child, the manager might not feel comfortable staying with the company. In that case the owner might need to set up contracts to keep the company’s valuable employees in place.
“We always advise thinking about goals and including exit strategies at the outset,” Madden said. “It can help alleviate or illuminate problems among owners down the road.”
Thinking about it sooner, rather than later, helps owners reach the outcome they desire.
“It’s not always possible to get the exact outcome you are looking for,” Madden said. “However, it is easier to get what you want when you know what you want.”
Hahn said business owners thinking about selling should give themselves two to three years to plan their exit strategy.
“Most people starting a business are thinking about how they start making positive cash flow,” he said. “They don’t start thinking about [exit strategies] until after they’re in business for a while. Often times they haven’t structured a company in a way to maximize the value of the company.”
